We are now less than two months away from Tesla's (NASDAQ:TSLA) long-awaited Model 3 reveal. One could make the argument that it's the start of the most important chapter in Tesla's history; the move from niche luxury automaker to a car priced for the mainstream US market.
The only things we know about the Model 3 are what Tesla has promised in various statements over the years:
- Range over 200 miles.
- Price starting at $35,000 before tax adjustments.
- A real practical car (seating for at least 4 or 5).
- Reveal in March 2016.
- First deliveries in late 2017.
Almost everyone, including me, has speculated about what the Model 3 might look like. Some people have submitted beautiful renderings. We have listened to every word about something that would give us a clue.
In the end, however, we know essentially nothing about what the Model 3 will look like specifically. To my knowledge, there has not been a single credible leak as to what the Model 3 will look like, whether there would be a single version of this car, or the presumed multiple versions. This particular discussion also does not require it, for it focuses on a different matter; the marketing message - and the resulting financing.
In trying to anticipate how Tesla will pitch the Model 3, I thought it instructive to basically write Tesla's press release (or on-stage presentation) the way I would do it if I were in charge of Tesla, so as to present the most bullish case possible. So here it goes:
Tesla is introducing today the car that almost everyone will want to buy. It will be among the faster cars ever made, with a spacious interior, one of the biggest touchscreens, with frequent over-the-air updates, comes with free fuel for life at our Supercharging stations we are building all over the country, and yes - it even drives itself, sort of. The price: $9,500.
Yes, you heard me right, and that's not a typo: $9,500.
For only $9,500, you Mr. and Mrs. America, can now order what is in effect the best car in the world, and drive it forever for free. The Tesla Model 3 is not only the best car you can buy in America, but also the least expensive.
You may be wondering how we can sell you the Model 3 and it will cost you only $9,500. That is certainly a legitimate question, and here is the answer without delay:
The gross MSRP is $35,000, which is what we have been promising all along. Then subtract the $7,500 Federal tax credit. Now you're at $27,500.
If you live in California and you are below 300% of the Federal poverty level, starting this Spring, you are eligible for a $4,000 rebate, up from the uniform $2,500 rebate previously. So now you're at $23,500.
Mind you, the story doesn't end here, but let's pause for a minute and ponder what this means if we stopped the calculation at this point. At $23,500, the Tesla Model 3 is cheaper than a loaded Hyundai Elantra or Nissan (OTCPK:NSANY) Sentra. None of those cars have a huge touchscreen, none of them drive themselves, none of them is as fast as a Porsche, none of them is frequently rejuvenated with over-the-air updates, and none of them come with free fuel for life. So which one would you rather buy?
But wait, there's more! At Tesla, we are assuming lifetime gasoline savings of $9,000. How do we get to $9,000? We are assuming 12,000 miles per year, 30 MPG and $3 per gallon, which yields $1,200 per year. Multiply by 7.5 years - just before our eight-year warranty expires, and you have $9,000.
Subtract $9,000 from the $23,500 tax after Federal and California tax incentives, and you're left with $14,500. That makes the Model 3 cost approximately as little as a Nissan Versa or Chevrolet (NYSE:GM) Spark.
However, incentives don't come only in the form of a check or other monetary subsidy. In California, the Tesla Model 3 will also be eligible for the white sticker. For those of you unfamiliar with California's white sticker, it's the one that will allow Tesla Model 3 drivers to be in the High Occupancy Vehicle (HOV) lane, otherwise referred to as the carpool lane, even with only one person in the car.
This white HOV sticker is a prime purchase motivation, and while it is impossible to assign a precise value on it, people tend to tell us that it's worth $5,000 to them. Depending on where you live and work, you might save up to an hour in your daily commute.
Subtracting the $5,000 value of the white HOV lane sticker is how we get from $14,500 to $9,500 - your net price (before sales tax) of buying a Tesla Model 3. You will be able to reserve yours at our website starting tomorrow, and we currently expect to begin production around the end of 2017.
For those of you who had a hard time following the math outlined above, here is a simplified table:
Gross purchase price: $35,000
Federal tax credit: $7,500
California state rebate: $4,000
7.5 year gasoline savings: $9,000
Value of California's white carpool sticker: $5,000
NET cost to the California consumer: $9,500
That's how I would write Tesla's pitch for the Model 3, and why the consumer cost will "really" be only $9,500 as opposed to the $35,000 that Tesla will be collecting. Actually, Tesla will collect ZEV (State of California Zero Emission Vehicle) credits as well, nominally four credits worth up to $5,000 each, for a total of $20,000.
Let's ponder that for a moment: Tesla collects $35,000 plus up to $20,000 in ZEV credits, for a total of $55,000. The consumer effectively pays $9,500 net of incentives. Basically the difference - $45,500 - is mostly a regulatory arbitrage based on Federal and CA state legislation favoring electric cars, and effectively subsidized by those who buy regular cars.
Taking the scenario to the next level, one might surmise that Tesla could get literally hundreds of thousands of reservations (refundable deposits) for the Model 3 in short order, perhaps within days or weeks after the Model 3 reveal in March. One could envision a second Tesla press release, within days after the Model 3 reveal, written something like this:
At 4:12 a.m. today, our ability to take more deposits for the Model 3 literally crashed our servers, so we are temporarily suspending further deposit intake. We hit 105,000 deposits in only little over 72 hours, and we are pausing the deposit intake until we are able to install new servers to process the off-the-hook demand.
If we extrapolate this record demand for the Model 3 into the future, we now think that we are on track to be a bigger company than Ford (NYSE:F) and GM in only a few years. However, we do not have the production capacity to meet such a high demand. We have only one factory, and even in the most optimistic scenario, this sole factory will not realistically have an annual output of over 500,000 cars per year, even after year 2020.
As a result, we are also announcing today an intended capital raise of $10 billion to fund several new factories. For starters, we need a factory in Asia, a second plant in the US, and one in Europe. We must begin this construction already in 2017 to have a chance at meeting this unprecedented demand for the Model 3.
Did you see what just happened here? This scenario suggests that Tesla would use the immediate aftermath of the Model 3 reveal to raise more money, seeing as the company is facing ongoing GAAP losses and even larger negative cash flows.
If Tesla can pull this off, several billion in new equity can go a long way to keep otherwise truly catastrophic financial scenarios at bay for a few more years. If that's all that the Model 3 reveal event in March manages to accomplish, my sense is that Tesla will view it as a huge success.
That's the bull case for Tesla, come this March 2016. You can imagine the media headlines; they almost write themselves: "Tesla's $9,500 dream car crashes the servers" and "Tesla gets 100,000 orders overnight for its impossibly affordable $9,500 self-driving car."
In the spirit of always being able to argue both sides of a case, I presented this scenario to multiple major automakers in recent weeks. Let's just say none of them seemed to have this scenario anywhere in their decision tree.
Of course, the bull case is not the only case.
So let's turn to the objections.
First, the Model 3 is approximately two years away from start of production, let alone significant volume, assuming no further delays. Contrary to popular rumor in Silicon Valley, the rest of the automotive industry is not sitting still, and will bring products of their own to market over the next 1-3 years.
We already know that the Chevrolet Bolt is scheduled to enter production before the end of this year, 2016, at least one full year before the arrival of Tesla's Model 3. Similarly, it is widely rumored that Nissan's LEAF 2.0, possibly with battery and range similar to Chevy Bolt and Tesla Model 3, will also enter production before the end of 2017.
Second, all the incentives and math (except one) that Tesla could use to argue that the price of the Model 3 will really be $9,500 and not $35,000, are available to the other automakers as well. The one exception is of course the "free electricity for life" coming from Tesla's superchargers.
Of course, that in turn begs the question: How can Tesla give free electricity for life? But that's the subject of another article.
Third, and perhaps most interestingly, what will happen to Model S and X sales once the Model 3 is available for order this March? Some will argue that those models don't compete with each other and that therefore the impact will be zero. I think that's a ridiculous argument, knowing that many people are "stretched" to buy the cheapest Tesla today, and that many could wait another two years to get a car that would cost half and still do almost everything today's $70,000+ Tesla models do. Of course Tesla, by revealing the Model 3, will cause some prospective buyers to forget about its existing models.
Fourth, I'm sort of sidestepping the whole argument about whether Tesla could make a profit selling even a bare-bones Model 3 for $35,000. I don't think that argument is totally relevant in the context of the impact of the Model 3 reveal this March. The thesis of whether the Model 3 can be made profitably for $35,000 or not will not be proven or disproven until well into 2018 at the very earliest.
This profitability-or-not-at-$35,000 argument is also overshadowed again by some basic competitive questions. If Tesla can make this kind of car for $35,000 at any given level of bottom line, surely another larger automaker can at least match this level. Furthermore, if Tesla can (through losses and capital injections) subsidize losses at the $35,000 level, so can any other automaker to an even greater degree. You can't change a car so easily once it's engineered, but you can change the price with a few keystrokes.
The battle that Tesla's competitors have in this war of words is that they risk being overwhelmed by the media attention that is likely to surround the Model 3 launch. The original news is carried on the front page, but the various "but" and "if" arguments show up in fine print at the bottom of page B26. In other words, "mainstream media" and the (non-automotive) tech press have a tendency to "report" claims in their most favorable light - see my two "press releases" above - and it could have a material impact on the stock price as well as Tesla's ability to raise more capital immediately thereafter.
The hard part comes after.
Tesla stock could pop on the Model 3 March reveal and the associated pitch that I described above. However, soon enough, it will be back to business as usual again: In early May, Tesla is scheduled to report 1Q earnings and there is no Model 3 revenue to be seen anytime soon. In the meantime, the focus will return to the Model X delivery ramp and what impact the Model 3 reveal will have on near-term orders for the Model S.
This will only intensify by the time Tesla reports 2Q results in early August. In addition, that's when we start approaching the Chevrolet Bolt production ramp. Once the Bolt gets in front of reviewers and at the end of the year, actual customers, GM has a product and Tesla does not yet have one - whether at $35,000 or at the $9,500 headline number, which is now what Chevrolet can effectively claim instead. That becomes a tough place for Tesla exiting 2016 and going into 2017.
Even more near term, the stock reaction to 4Q 2015 earnings on February 10 could be hard to gauge. On the one hand, the bottom line is being revised downward and recent forum reports suggest that Model X deliveries remain slow thus far in 1Q.
On the other hand, with only approximately a month go to until the Model 3 reveal, what would Tesla do to accelerate some of the excitement of the Model 3 into the 4Q earnings report on February 10? I have absolutely no idea, but there could perhaps be a way to do it that diffused the attention away from the actual 4Q results and outlook for 1Q.
Short term (February 10 earnings report): Will advancing Model 3 announcement excitement soften any impact from potentially poor 4Q financials and 1Q outlook? Uncertain either way.
Medium term (late February to late April): Model 3 excitement could be exceptional, and could cause the stock to rally.
Longer term (after April): Following the Model 3 reveal, there's an 18 month "walk in the desert" where Tesla has to meet financial realities and increasing competitive pressures, starting with the Chevrolet Bolt and with many other cars to come in 2017 and into 2018. The stock may give back what it might have gained in and around March 2016.
Disclosure: I am/we are short TSLA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: At the time of submitting this article for publication, the author was short TSLA. However, positions can change at any time. The author regularly attends press conferences, new vehicle launches and equivalent by most major automakers, including Ford, GM, Hyundai and Nissan, and those events are sometimes hosted by those automakers.